Is SELVAS Healthcare (KOSDAQ:208370) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that SELVAS Healthcare, Inc. (KOSDAQ:208370) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for SELVAS Healthcare

How Much Debt Does SELVAS Healthcare Carry?

You can click the graphic below for the historical numbers, but it shows that SELVAS Healthcare had ₩16.7b of debt in September 2020, down from ₩21.5b, one year before. On the flip side, it has ₩12.7b in cash leading to net debt of about ₩3.98b.

How Healthy Is SELVAS Healthcare's Balance Sheet?

We can see from the most recent balance sheet that SELVAS Healthcare had liabilities of ₩16.1b falling due within a year, and liabilities of ₩5.33b due beyond that. On the other hand, it had cash of ₩12.7b and ₩3.43b worth of receivables due within a year. So its liabilities total ₩5.29b more than the combination of its cash and short-term receivables.

Given SELVAS Healthcare has a market capitalization of ₩54.8b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Given net debt is only 1.0 times EBITDA, it is initially surprising to see that SELVAS Healthcare's EBIT has low interest coverage of 2.3 times. So while we're not necessarily alarmed we think that its debt is far from trivial. We also note that SELVAS Healthcare improved its EBIT from a last year's loss to a positive ₩1.6b. There's no doubt that we learn most about debt from the balance sheet. But it is SELVAS Healthcare's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, SELVAS Healthcare actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

SELVAS Healthcare's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its interest cover has the opposite effect. We would also note that Medical Equipment industry companies like SELVAS Healthcare commonly do use debt without problems. When we consider the range of factors above, it looks like SELVAS Healthcare is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that SELVAS Healthcare is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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